Growth vs Value stocks: 2020 investment outlook

For the past decade, investors have piled in on growth stocks and tended towards a strategy that banks on disruptive companies expecting to increase earnings at an above-average rate. As a result, ground-breaking businesses such as Amazon [AMZN], Domino’s [DPZ] and Netflix [NFLX] have offered up some of the most spectacular gains ever seen in the market. So is there a place for value stocks in investors’ portfolios?

During this period, however, the gap between those investing in growth stocks and those investing in value stocks – a strategy where investors pick stocks that appear to be trading less than their intrinsic value – has grown wider and wider. This has offered up new opportunities for investors, who have already shown signs of switching tact into the new year. Will this gap continue to grow, or are value stocks prime for a comeback?

A decade for growth

Many see the 2010s as a golden era for growth stock investment. Money flowed into these stocks, as the Federal Reserve loosened interest rates and banks were helped to recover from the 2008 financial crisis. At the same time, new technology from Silicon Valley created optimism as traditional businesses were disrupted – pushing gains higher and higher.

It has been a decade of growth, with the Russell 1000 Growth index climbing 258%, while the Russell 1000 Value index lagged behind at 137%, figures from Yahoo Finance show. Some of the biggest drivers of this approach were the FAANG stocks – Facebook [FB], Amazon, Apple [AAPL], Netflix and Google [GOOGL] – which shook up traditional industries and created new models for them. Throughout the decade “investors only needed to know this one acronym to succeed,” CNBC notes.

258%

Increase of Russell 1000 Growth index over past decade

Advice not without merit, FAANG stocks have overwhelmingly outperformed the S&P 500 over the past five years, and largely helped carry the index to new highs. Netflix, for example, outperformed the S&P 500 by gaining 515% between 2014 and the end of 2019, while the index rose by only 74% in the same period of time.

What investors have learnt

However, during this period the gap between investors in growth and those investing in value stocks has be “extreme”, Mario Glogović writes in Seeking Alpha. The success of top-performing disruptive companies seems to have set a bad precedent, however. In this scenario, investors seem to reward growth trajectories over profitability and leaps of faith over proven business value.

Corporate debt levels rose from $4.9tn in 2007 to nearly $9.1tn halfway through 2018, according to data from Securities Industry and Financial Markets Association. During this time a number of businesses made bold, and costly, promises that would not always lead to profit.

$9.1trillion

Corporate debt levels in 2018 - a rise from $4.9tn in 2007

The issue came to a head in 2019, as a string of high-profile initial public stock offerings struggled amid growing cynicism. Perhaps capping the optimism on high growth stocks was WeWork’s failed attempt to list, as intense scrutiny over the decision led the company to cut its valuation from $47bn down to $5bn. Its CEO Adam Neumann swiftly stepped down in the wake of the failed IPO.

Investor outlook for 2020

While a clean cut from growth investing is unlikely, a rotation into value stocks has begun as a result of these incidents. Many forecast value investing to grow in the coming decade, but this shift will likely be gradual.

“While the rotation towards value started in September… we think it is still in its early stages,” Marko Kolanovic, global head of macro quantitative and derivatives research at JP Morgan, wrote in a note in December. This rotation is likely to continue to appear into the first quarter, he suggested.

A range of factors will impact how much value investing will truly gain momentum. “Value stocks have fared best during periods of very strong or very weak economic activity,” Goldman Sachs analysts wrote in a note to investors in October. “Sustained value stock outperformance, therefore, appears unlikely unless the pace of economic growth either rebounds sharply … or falls into a recession. We believe neither of these scenarios is likely.”

“Value stocks have fared best during periods of very strong or very weak economic activity. Sustained value stock outperformance, therefore, appears unlikely unless the pace of economic growth either rebounds sharply … or falls into a recession. We believe neither of these scenarios is likely” - Goldman Sachs analysts

This may be the best time to invest in value stocks, as bargain prices could put investors ahead of the game, Glogović explains. A group of 30 low-value stocks offered an average yield of 3.4%, according to the analyst, significantly higher than the S&P 500’s yield of 1.89%.

Meanwhile, Bank of America Merrill Lynch says that the only time value stocks have come this cheap was in 2003 and 2008. “Amid macro uncertainty, valuation dispersion has risen to the highest levels since the financial crisis,” the bank wrote in a note in September.

“When valuation dispersion was this high or higher, value stocks have consistently outperformed growth (95% of the time) over the subsequent 12 months, by 24ppt on average.”

While the likes of Facebook and Netflix may be getting to a more mature phase, there is still one high-growth social stock that could provide promising returns into the new year. Pinterest’s monthly user count increased by 71 million at the end of September 2019 to 322 million from the same period last year. The growth is said to be coming from international markets, more than doubling year-over-year average revenue per user to 13 cents, compared to 6 cents in the prior-year quarter. Analysts are also betting that the company is looking to turn a profit for the first time in 2020.

Nasdaq pits semiconductor company Broadcom as one of the most valuable stocks available to investors today. In 2018, the company racked up $18.46bn in revenue and Q4 earnings saw the company beat forecasts on both earnings and revenue, giving promising signs for full-year 2019 results (expected to be announced in March). Most importantly, the company recently raised its dividend payments, giving it a yield of 4.34%, above the 2% average among S&P-listed companies, making this a key value stock to watch in 2020.

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